Tuesday, March 16, 2010

Economics of free stuff

When I first came across a concept of “giving away freebies to make money” I did not quite understand how powerful this business model can be. What seems like totally contradictory terms when used in one sentence, that is “free” and “making money”, in fact are quite logical “cause and effect” when analysed in more depth.

The whole concept is not a “new invention” and has been around for a while. Free-to-air television and radio networks have been using this business model quite successfully for decades. Google is probably the best example of an online commercial entity that mastered the concept to the extent that the company is now one of the most valuable corporations in the world. It makes billions in revenue from advertising while offering ever expanding range of free services and online tools. It turns out that the audience attracted to free services is more valuable than what could be otherwise extracted form payments for the services they consume.

I developed a few freebies as a test case for promoting my aus-emaps.com site but it turns out the real benefits of providing free stuff can be far more reaching. I will use my weather widget example to demonstrate the point.

Let’s say “the cost” of developing this widget was a few hundred dollars. In February it was used by 15,000 people (unique visitors) and the page was served 100,000 times. It is a tiny 190px by 190px application and can easily be customised for embedding into web pages. So, what do I “get” in return for providing this free service?

Firstly, there is a range of intangible benefits that are rather difficult to measure at this stage, such as increased brand awareness (the application carries a tag line “free from aus-emaps.com”) and specific market positioning (“I know how to do this kind of stuff, ask me to build something for you”). Then there are things I can measure more precisely. For example, in February 6% of weather widget users clicked on aus-emaps.com URL to visit my site. It translated to 1,760 visitors that otherwise would not find my site. To get this volume of traffic from Google Adwords would cost me approximately $180. That is the money I did not have to spend so it goes straight to the bottom line. But there is more. Average click-through rate on Adsense ads on my site is just over 3%. Which translates to extra 45-50 clicks on paying ads. And this is pure profit. My site is tiny so it all does not account to much at all but consider a case of Mr Murdoch’s online empire. If he would only entertain an idea of freeing up the content of his media assets with similar widgets and services… or at least some of that content.

There are other tangible measures that may be applicable as well. For example, if I knew retention rate for new visitors I could put additional value on those 1,760 extra users of aus-emaps.com. To illustrate, if retention rate is 3% those extra 50 users would also have a long term “economic value”- I demonstrated in one of my earlier posts that advertising revenue and value of the website increases exponentially with the increase in patronage. For smaller sites those loyal customers carry only a value of a few cents but for larger sites they can be a very valuable commodity (eg. for a site with 1 million unique visitors one loyal user can be worth even $2-3 in annual advertising revenue and can add from $2-8 to the value of the site).

And to maximise the value of a freebie "all the way", there is also an opportunity to start selling promotional messages on a widget itself. If done correctly it will not diminish the attractiveness of the widget to webmasters.

All in all, freebies can be a kind of “self propelling force” that exponentially increases traffic to the site. That is, the more people use the freebie, the more new visitors will follow through to the originating site. If only a fraction of those visitors become regular users of the site, the loyal user base will grow at an exponential rate. And that is why giving away free stuff can help you make money in the long run…